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Passive investing has changed one of the biggest retirement debates

Ethan Wolff-Mann
Senior Writer
Passive investing, technology, and public expectations have changed the landscape of the fiduciary rule discussion. REUTERS/Gary Cameron/File Photo

The Department of Labor’s fiduciary rule suffered a major blow Thursday, as a federal appeals court overturned a district court’s ruling in favor of the rule. The case will likely end up going to a higher court or extend to more than the three-judge panel.

The fiduciary rule, pushed forward by the Obama administration, partially went into effect in 2017. It requires financial advisors to put their customers’ interests first, instead of steering them towards more expensive retirement products that offer commissions.

Previously, the long-standing suitability standard required a broker or retirement advisor to sell something that was merely “suitable” to a consumer. A White House study from 2015 had found $17 billion was lost by retirees due to conflicts of interest.

The argument against a fiduciary rule is that it would make investment advice too expensive for some people. House Financial Services Committee Chair Jeb Hensarling (R-Tex.) lauded the ruling as a preservation of “access, choice and affordability.”

This echoes somewhat what the new SEC commissioner Hester Peirce said, according to Investment News, about the need to keep options open for consumers so they can get advice via a broker or an advisor.

The SEC is working on a version of a fiduciary rule that could emerge before July that would likely be weaker than the DOL’s. The Commission would redefine what “fiduciary” means. Peirce also said she was open to clarifying what all these parties could call themselves, as consumers are often in the dark about the type of advice they’re receiving and what the difference between a broker and an advisor is.

“The original proposal will never be fully implemented,” Greg Valliere, chief global strategist for Horizon Investments, wrote in a Friday note. “Its legacy may be that while it burdened small firms, it has prompted tougher self-regulation by the industry as a whole.”

The rule, in a 2018 context

These debates seem to have lost sight of a few industry realities that have both altered the stakes and deflated some of the arguments. Already, many financial service providers serve in a fiduciary capacity, because they do not want the compliance headache of flip-flopping standards.

“Yesterday’s decision introduces more uncertainty into a process that has been drawn out and fraught with ambiguity,” Tom Rampulla, managing director of Vanguard Financial Advisor Services, told Yahoo Finance. “Fortunately, much of the industry has already shifted towards improved transparency, and we expect that positive momentum to continue.”

Furthermore, Rampulla noted that customer demand also drives this decisionmaking — highlighting the market reasons as well as a regulatory reasons. With a great deal of media coverage, this issue is far more visible than it had been in the past, educating some consumers. And these educated consumers will not stand for bad advice.

“Advice should be delivered in a client’s best interest, and investors are already expecting and demanding change,” Rampulla said.

Passive investing and and ETFs

The passive investing revolution scarcely gets a mention in fiduciary rule discussions, but is the elephant in the room thanks to its low fees and very simple math.

At Yahoo Finance one of the maxims that often gets passed around is that the best way to beat the market is to win on fees, something that makes the financial “choice” arguments sound flimsy. Fee calculations underscore the importance of steering clear from less-than fiduciary advice.

A difference of a measly 2% fee could eat literally half of growth over a 25-year period, according to Vanguard’s calculations. An initial investment of $100,000 with a 2% fee would net around $160,000 in earnings, while no fees would get you to $330,000. Many indexed ETFs offer fees that approach that magical 0.00% fee mark and generate returns that are about as good as anything else on average.

This explains some of the influxes of capital into passive, indexed investment vehicles, as well as their distinct one-size-fits-all nature. Many financial planning experts will simply recommend owning the market for almost no fees instead of picking stocks.

The fiduciary opponents, however, do have a point about the utility of advisors. It’s not about telling what consumers should buy but more about telling them not to panic and sell — a feature that’s often hard to remember in a bull market.

That, however, offers a much simpler bar to clear, something that could clear up the “access” issues put forth by people who are concerned about the fiduciary rule.

Advice in the passive investing era

The flow of retirement funds into passive investments — and outflows from active funds — makes the “passive era” more important as a concept than a “fiduciary rule” era. Since there is broad consensus that index funds and ETFs are good places for retirement savings for most people, the standard of advice required changes sharply. People need less.

Robo-advisors Betterment, as well as its competitor Wealthfront, will be continuing to offer low-cost fiduciary advice for investors, regardless of the rule’s eventual outcome. Vanguard’s advisor services remain fiduciary as well.

At the end of all this, the Department of Labor rule will either emerge solidified, or investors will continue to wait for the SEC’s version. But regardless, the entire landscape will have changed from the debate alone, and from technology and the shifts to passive investments.

“Throughout the fight for the fiduciary rule, we’ve seen positive evolution in financial services,” Jon Stein, founder and CEO of Betterment told Yahoo Finance, “including easier access to low-cost investments and heightened awareness of how financial providers are compensated.”

Ethan Wolff-Mann is a writer at Yahoo Finance. Follow him on Twitter @ewolffmann. Confidential tip line: FinanceTips[at]oath[.com].

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